Why slowing growth doesn’t mean recession

In late 2017, Oxford Economics started warning its clients about the risks of a US economic slow- down in 2020. The reasoning was that the anticipated fiscal stimulus programme would temporarily boost GDP growth in 2018 and early 2019, but its effects would dissipate in 2020.

At the same time, tighter monetary policy and a more protectionist stance would weigh on growth and deter private sector activity with GDP growth slowing from 2.9% in 2018 to 2.5% in 2019 and 1.7% in 2020.

Fast forward to the end of 2018, and it has now become fashionable to call a recession in 2020. The renowned National Association for Business Economics survey of over 50 professional forecasters shows two thirds of respondents expecting a recession before the end of 2020, and 56% expecting a recession in 2020.

While these statistics sound worrisome, they should be understood in the context of a resilient US economy. The US is currently in its second longest expansion on record with the economy having grown for more than 110 consecutive months. Real GDP growth clocked in at 3.5% (saar) in Q3, following a 4.2% advance in Q2, and the US economy may even register its strongest annual performance since 2005 with growth at 2.9%.

While the economy may be more vulnerable to adverse shocks in 2019 and 2020, including a stronger dollar, weaker emerging markets growth, an adverse oil price shock, or a stock market correction, none guarantee the boat will sink in the next two years, and by that time, the “2020 recession call” may no longer be fashionable. Our baseline sees GDP growth slowing toward potential output growth by 2020 as policy becomes less supportive.

The main trade policy risk lies in the possibility of all-out trade war between the world’s two largest economies. The administration continues to convey myths that trade deficits are inherently bad, caused by unfair trade practices, and that protection- ism is the solution. President Trump has imposed successive waves of tariffs on trading partners.

China has been the primary target of these measures with the implementation of 10% tariffs on $200bn of imports as of 24 September (on top of the existing 25% tariffs on $50bn of imports), and threats to increase the tariffs to 25% on 1 January, and impose duties on all imports from China in 2019.

While our baseline assumes a 0.2ppt drag on GDP growth from 25% tariffs on half of our imports from China, the consequence of a full-out trade war would be more damaging to the two protagonists and the rest of the world.

Macroeconomic simulations, using our Global Economic Model, point to US GDP losses around 0.4ppt in 2019 for the US, and potentially more for China.
The main monetary policy risk stems from the possibility of “excessive” tightening that would constrain private sector activity and weigh on growth.

Prices and input costs have been rising steadily with consumer price inflation hovering around the Fed’s 2% inflation target, and there are indications that core inflationary pressure may yet rise further as the economy continues to expand and import tariffs filter through.

While this steady rise in prices doesn’t portend spiralling inflation, it does translate into reduced marginal spending capacity for households – restraining the main engine of economic growth. Rising inflation comes at a time when the Fed has appeared more hawkish. While our baseline assumes the Fed will proceed with a fourth rate hike in December, and three increases in 2019, a more hawkish Fed could weigh on activity.

For instance, should there be a fourth rate hike next year, growth might be constrained by 0.3ppt. The key question will therefore be whether Federal Reserve chairman Jerome Powell’s pragmatic “risk management” doctrine avoids the Fed falling into prior pitfalls of excessive tightening.

The main fiscal policy risk comes from the fact that the strong stimulus to the economy in 2018 will gradually weaken over 2019 and fully dissipate in 2020. The Tax Cuts and Jobs Act and Bipartisan Budget Act are expected to add around 0.7ppt to GDP growth in 2018 and contribute around 0.5ppt to growth in 2019.

However, the marginal boost to growth will have largely disappeared by 2020. While the fading fiscal boost is embedded in our baseline, the economy could face a mini-fiscal cliff (worth 0.3ppt) in 2020 as government outlays will fall back below the spending caps introduced by the Budget Control Act of 2011.